LIBOR Rigging: What the Regulators Saw (but Didn’t Shut Down)

Why weren’t the first signs taken more seriously? Has there been a serious failure of regulation, or are there strong mitigating circumstances that could explain and justify the lack of resolute action?

Thanks to the New York Federal Reserve, we now know that both the Fed and the Bank of England could see and were being told that something was awry with the London interbank offered rate (LIBOR) already in late 2007. Yet it was several months before any regulator began an official inquiry into alleged manipulation of this key money-market rate, which is used as the basis for trillions of dollars of financial transactions around the world — and there appears to have been no serious attempt made to stamp out the practice at the time.

That in turn begs the question: Why weren’t the first signs taken more seriously? Has there been a serious failure of regulation, or are there strong mitigating circumstances that could explain and justify the lack of resolute action?

Lawmakers on both sides of the Atlantic are now trying to answer those questions, with investigations taking place both in Britain, where the Treasury Select Committee has been probing the affair, and in the U.S., where the House of Representatives’ Committee on Financial Services’ Oversight Subcommittee and the Senate Banking Committee are investigating.

So far, the only identified culprit is the British bank Barclays, which agreed in late June to pay a $450 million fine to settle manipulation charges brought by the U.S. Commodity Futures Trading Commission (CFTC) and Britain’s Financial Services Authority. Investigations of other participants in the LIBOR process are continuing in the U.K., the U.S. and Germany, by both regulators and fraud investigators.

Barclays itself says others are involved. In an internal memo sent on July 13, the bank’s executive committee urges the bank’s staff to “remain vigilant on balance-sheet exposures and risk management,” given the difficult financial and economic climate. The memo apologized for the impact of the LIBOR fine, but it suggested that others could soon be implicated. “As other banks settle with authorities, and their details become public, and various governments’ inquiries shed more light, our situation will eventually be put in perspective,” according to the memo, which was first disclosed by Sky News.

In Germany, Deutsche Bank had no comment on a report over the weekend in the newsmagazine Der Spiegel, which said that in 2011 the German bank had already sought to strike an arrangement with investigators in Europe and Switzerland that would reduce any eventual sanction in the LIBOR affair.

The LIBOR rates, which cover 10 currencies, are set every day by a cluster of banks. There are currently 18 banks in the panel for the U.S.-dollar rates. They include Bank of America, Citibank, JPMorgan Chase, HSBC, UBS, Bank of Tokyo-Mitsubishi UFJ, Société Générale, BNP Paribas and the Royal Bank of Scotland. Many of the same banks are in the panels for the other currencies. The full list of which banks participate in which rate fixings is available here.

The document dumped by the New York Fed to the House subcommittee includes e-mails and transcripts of phone calls with Barclays bankers. “Suggestions that some banks could be underreporting their LIBOR in order to avoid appearing weak were present in anecdotal reports and mass-distribution emails, including from Barclays, as well as in a December 2007 phone call with Barclays noting that reported ‘Libors’ appeared unrealistically low,” the Fed said in a statement.

Among the evidence was an exchange between the New York Fed’s Fabiola Ravazzolo and an unnamed Barclays banker. After some initial jocular small talk, Ravazzolo asked pointedly about the reliability of the U.S. LIBOR rate. The Barclays person acknowledged that the bank had been submitting rates “where we really thought we would be able to borrow.” But because those rates were higher than those posted by other banks, Barclays stock was falling. “So we just fit in with the rest of the crowd,” the banker said. “We know that we’re not posting, um, an honest LIBOR … And yet and yet we are doing it, because, um, if we didn’t do it, it draws, um, unwanted attention to ourselves.”

That same day, a briefing note that is circulated to senior officials at the New York Fed, the Federal Reserve Board of Governors, other Federal Reserve banks and U.S. Department of Treasury contained a discussion of LIBOR’s problems, including a reference to “a significant amount of questions over [its] accuracy.”

These documents provide detailed corroboration of suspicions that the Bank of England also had starting in late 2007. At a parliamentary hearing on July 9, the bank’s deputy governor, Paul Tucker, was asked about a November 2007 meeting of the Bank of England’s Sterling Money Market Liaison Group, which discussed why LIBOR fixings had been lower than actual traded interbank rates. Tucker said the bank hadn’t taken this to mean that some of the LIBOR banks were lowballing their submissions. “We thought it was a malfunctioning market, not a dishonest market,” he said.

That didn’t go down well with the committee chairman, Andrew Tyrie, who told Tucker: “I have to tell you, it doesn’t look good. We have in the minutes from 15 November 2007 what appears to any reasonable person to be a clear indication of lowballing about which nothing was done.”

In the end, it was the U.S. that moved first. Timothy Geithner, the U.S. Treasury Secretary who was then head of the New York Fed, on June 1 sent a short memo to Mervyn King, the governor of the Bank of England, with suggestions for how to bolster the LIBOR process. Among the suggestions: “establish a credible reporting procedure” and put more U.S. banks in the LIBOR dollar panel. A few days earlier, the CFTC launched its investigation, which Britain’s Financial Services Authority later joined. But the British authorities, who have regulatory oversight over LIBOR, at the time did nothing to crack down on any manipulation — and still have not put together any substantial proposals for an overhaul.

So did the central banks and regulators drop the ball in 2007? It’s still too early to tell, based on the evidence that’s emerged so far. Certainly there were mitigating circumstances: starting in August 2007, the world was suddenly caught up in a growing financial crisis, and central bankers started flooding the markets with liquidity as interbank lending dried up. That situation reached a crisis point after the bankruptcy of Lehman Brothers in September 2008. In those exceptional circumstances, it’s easy to make a case that the LIBOR problems were just a puzzling sideshow to the bigger bank-funding troubles. Geoffrey Wood, a professor at London’s CASS Business School, says that “when the markets are not functioning at all and there aren’t any transactions taking place, LIBOR is very difficult to estimate.” Indeed, he says, “in crisis episodes, all sorts of things are done.”

Yet LIBOR is at the core of world financial markets, used as the basis for credit-card and home-mortgage rates, among many other things, and the lag of almost five years between the initial identification of problems and the first settlement with Barclays is a very long time indeed. The CFTC found that Barclays had actually been manipulating the rate starting in 2005, well before the financial crisis, and today there has still not been any substantial change to the self-regulated fixing system underlying LIBOR. Geithner’s 2008 recommendations, for example, were just passed on by the Bank of England’s King to the British Bankers’ Association, which oversees the LIBOR fixing.

With banks in the LIBOR panels now facing likely massive class-action lawsuits, and potentially regulatory and even criminal complaints, they have every interest to shift the blame onto the central banks and regulators. Barclays’ ousted chief executive Bob Diamond already made a not-so-subtle attempt to do so just after he resigned: he released transcripts of a conversation he had with Tucker in October 2008, at the height of the financial crisis, and just as Barclays was seeking to raise fresh capital from Middle Eastern investors in order to avoid nationalization by the U.K. government. In Diamond’s transcript, Tucker’s comments could be interpreted as condoning Barclays’ lowball submissions, although Tucker himself strongly denied that. It may well be have been the first blow in a bankers-vs.-regulators who’s-to-blame game that looks set to run for quite a time.

Peter Gumbel writes about European business and finance from Paris, where he has lived since 2002. He was worked as a staff writer for The Wall Street Journal, TIME and Fortune. The London-based Work Foundation named him "Journalist of the Year" in 2005.

Gumbel's latest book is France's Got Talent: the woeful consequences of French elitism. A digital version is available in English.